Price of Coal
Coal has been used historically as a source of energy for years. Its production infrastructure, transportation and distribution routes, markets, and uses have matured and are well developed around the world. That is why we see that the relationship between the price of coal (as a basic energy
EXHIBIT 6.12 Price of Homes in Rice
EXHIBIT 6.13 Price of Homes in Wheat
commodity in the matrix of needs of consumers) and the price of other commodities, such as gold, rice, or wheat, fluctuates in a narrower band than that of oil (see Exhibits 6.14 and 6.15).
Price of Each Short Ton of Coal in Dollars
EXHIBIT 6.14 Coal Prices, 1968-2013
Price of Each Short Ton of Coal in Ounces of Gold
EXHIBIT 6.15 Price of Coal in Ounces of Gold
Based on Exhibit 6.15, the price of coal, which kept rising in dollar denomination, went down in real value — in terms of gold — after 1971, and kept fluctuating in a range of 0.06 to 0.1 ounces of gold for every ton of bituminous coal.
Price of Crude Oil
The oil market followed the same pattern that we saw in the coal market. Crude oil and the refined products markets have also developed and matured over the years. That is why, as we found in the case of coal, we can safely look at oil price gyrations in the market to try to learn the relationship between the price of oil and that of other commodities. The chart in Exhibit 6.16 is intriguing. It shows that despite the large rise in oil prices in terms of U.S. dollars, in normal times, the price of oil in terms of gold is stable, ranging from 0.06 to 0.12 ounces of gold per barrel of oil (10 to 20 barrels of oil for every ounce of gold), with an average price of 0.085 ounces of gold per barrel of oil (12 to 13 barrels of oil per ounce of gold). In fact, based on my 14-year experience in the oil industry — 10 of these years were with
Price of Each Barrel of Oil in Ounces of Gold
EXHIBIT 6.16 Price of Oil in Ounces of Gold
a major United States-based oil company — we considered 10 to 13 barrels of oil per ounce of gold a fair value. This “technical analysis” was shared by me with some of the distinguished “technical analysts” at Smith Barney/ Citigroup in 1999, and they started tracking the relationship and using it as an important indicator for oil price trends.
We can see from Exhibit 6.16 that if the value of oil in terms of gold increases and penetrates the upper boundary of 0.12 ounces of gold per barrel of oil (e.g., 8 barrels of oil per ounce of gold), oil is overpriced and it is an indicator to sell the oil to avoid participating in a bubble. However, if the price of oil is low and pierces the lower level of the envelope at 0.06 ounces of gold per barrel of oil (e.g., 17 barrels of oil per ounce of gold), it is an indicator to buy (go long on) oil. It is very interesting to note that spikes in the oil price in terms of gold reflect political and economic changes that occurred over the course of history. For example, before the first oil shock in 1973, the value of oil spiked from 10 barrels per ounce of gold to approximately 35 barrels per ounce of gold, creating hugely undervalued oil and prompting higher demand — which later created a great supply shortfall, leading to the increase in oil price from $2.50 per barrel to approximately $12 per barrel. Looking into the history of this period, one sees that this was the time when most of the oil-producing countries were renegotiating their oil production participation agreements to increase their share of the production and hence reduce the share that would strategically go to the oil companies. This situation created the incentive, on the part of the producing oil companies, to produce as much oil as possible in the shortest time available, flooding the markets with oil and later creating a supply shortfall that nudged oil prices higher. It is also interesting to note the clear indication of a bubble during major world events.
In the summer of 2008, the oil price had reached a level of approximately $135 per barrel, while gold has reached approximately $885 per ounce. That is, the value of oil reached approximately 6.6 barrels per ounce of gold. Based on the Commodity Indexation Discipline, it was concluded that the price of oil is very high and is overvalued compared to an equilibrium market price. Based on our previous analysis, one expects that this ratio should go back to at least 10 barrels of oil per ounce of gold. At a gold price of $885 per ounce, that would translate to an oil price of $88.50 per barrel. At a gold price of $750 per ounce, and with a most likely oil price index of 10 to 13 barrels per ounce of gold, then one can expect fair value for the oil price to reach $58 to $75 per barrel.
World oil price declined from its peak in the summer of 2008 to as low as $35 per barrel and stabilized at about $50 per barrel in April 2009 and resumed its rise progressively, as shown in the chart. This fluctuation depends on the U.S. dollar's value on the international markets; the price of commodities that underlie the U.S. economy (because it is one of the larger importers of crude oil in the world); and the U.S. government's and Federal Reserve Board's policies regarding the dollar, interest rate, and economic and monetary policies (both in the United States and in the major economies in Canada, Europe, and the United Kingdom). Other important factors are the speculative activities of hedge funds, armed with huge amounts of capital, in the futures and options markets in the oil, gold, and dollar markets. It is interesting to note the cyclical nature of very high oil prices (overpriced oil) followed by another period of very low prices (underpriced oil). Students of history may find a relationship between capital accumulations by the major oil companies during the overpriced stage followed by an intensive record of negotiating new oil exploration contracts in new areas, coinciding with much lower prices.
The prices of some other commodities are charted in the following sections to give the reader a full scope of the validity of the RF Commodity Indexation Discipline. It is sincerely hoped that a group of researchers will take it upon themselves to research these relationships, not only in terms of relative prices but also in terms of stochastic mechanistic analysis, such as determining how much energy is consumed to produce an ounce of gold and how this impacts oil prices. This will not only include the cost of fuel, but also the amount of human energy consumed in exploring for gold, refining it, making it into standardized ingots, transporting it, and storing it.
